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Why the Wall Street Welfare? Four Questions for Goldman Sachs

As Goldman Sachs (GS) executives prepare to testify before a Senate committee on Tuesday, the politicians had better prepare a good brief for the Wall Street titans. These are smart guys. But for once, legislators have the benefit of good inside information, exactly what traders respect, to back up their case.

The overarching theme of the questions should focus on why Goldman ought to be the beneficiary of Wall Street Welfare -- that pungent mix of implicit government guarantees, explicit government assistance and political deference that has been so central to the financial industry's explosive growth over the last 25 years.

Yes, Goldman Sachs is on "welfare," a word describing government programs designed to help the most vulnerable -- mostly the poor -- pay their heating bills, feed their children or get health care. Goldman may not be needy, but it did get bailout money from the feds (please, no lines about how they didn't want it -- a bank outside the federal embrace in November 2008 was a dead bank). And it has access to cheap Federal Reserve loans. And the government ensured that taxpayers, via AIG, paid off its credit default swaps.

The federal government did that because a healthy economy needs healthy banks to allocate credit. Lloyd Blankfein once described this role as "doing God's work," but a smart prosecutor's brief, here in the court of public opinion, could reveal how crazy that statement is in the case of Goldman. Hoist them on their own petards, senators. You have the chance to make out of this spectacle a 2010 version of the Pecora Commission that so thoroughly exposed Wall Street in the 1930s. Don't blow it!

1. The U.S. government stepped in to rescue the financial system in the fall of 2008 because of its important function of channeling credit to the broader economy. The Abacus securities highlight for all of us how investment banks have grown wealthy without delivering any socially redeeming value. If banks get any kind of support from the government, then they have to constantly ensure that they do what banks are supposed to. Goldman, the SEC charges, designed synthetic CDOs, known as the Abacus bonds, to fall in value so that their megabucks client, John Paulson, could bet against their demise. In other words, capital would flow from Goldman's less favored clients to Paulson's pocket. Don't let yourselves be distracted by obfuscations like "our business is client-driven" or some such. If Goldman did this particular deal, and it sees no problem with that deal, then why shouldn't regulators stop such deals in the future.

2. Fabrice Tourre, the trader at the center of the SEC, has referred to the Abacus securities as "pure intellectual masturbation," a bit of locker-room talk via email that really exposes what you're up to here. Mr. Tourre told us point-blank the Abacus deals had no useful purpose. (Really, his dismissive tone says all we need to hear, but if you love 'intellectual,' here goes.) They financialized, to use an ugly word, an intellectual construct against which a big Goldman client could bet. He added in another email that no one really knows how to price these securities, which is reason enough to eliminate this kind of activity from our financial landscape. We embrace capitalism in this country because it is good at creating socially redeeming value, so if you can't sensibly assign a price to it then it has no such value.

3. Investors, as a general rule, should be able to assume that investment banks underwrite securities designed to deliver the best possible return for that asset class. Don't think we're going to stand by while you undermine a basic principle of financial markets. Goldman argues that it created the Abacus securities and then sold them to extremely sophisticated investors who should have known the risks they were taking. This is lunacy. If I get into a car, even the most sophisticated person is unlikely to consider the possibility that the manufacturer designed it to crash. But that's what Goldman did with the Abacus bonds.

4. For the life of us, we can't understand why you decided your own self-interest was to do this. Goldman clients who are not named John Paulson must be furious. Now they have to worry that there might be a more valuable client than themselves out there in whose interest Goldman is really working. There was a time when investment bankers rose or fell based on their reputation for protecting the client, but that ethos appears to have all but vanished. If the re-regulation of financial services does nothing more than refocus investment bankers on who really matters - the client - then it will have been worth it. And in case you're banking on the millions that Goldman Sachs pumps into the political process, remember that there are more clients, also known as voters, than there are Goldmans.